Most readers would already be aware that Shanghai Kindly Medical Instruments' (HKG:1501) stock increased significantly by 57% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Shanghai Kindly Medical Instruments' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Shanghai Kindly Medical Instruments

How Is ROE Calculated?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai Kindly Medical Instruments is:

9.8% = CN¥140m ÷ CN¥1.4b (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.10 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Shanghai Kindly Medical Instruments' Earnings Growth And 9.8% ROE

At first glance, Shanghai Kindly Medical Instruments seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. This probably goes some way in explaining Shanghai Kindly Medical Instruments' significant 22% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Shanghai Kindly Medical Instruments' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 19% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Shanghai Kindly Medical Instruments fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shanghai Kindly Medical Instruments Efficiently Re-investing Its Profits?

Shanghai Kindly Medical Instruments' three-year median payout ratio is a pretty moderate 34%, meaning the company retains 66% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Shanghai Kindly Medical Instruments is reinvesting its earnings efficiently.

While Shanghai Kindly Medical Instruments has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 50% over the next three years. Still, forecasts suggest that Shanghai Kindly Medical Instruments' future ROE will rise to 25% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we are quite pleased with Shanghai Kindly Medical Instruments' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.